2.2 Enseñanza de la matemática
2.2.2 Rol de las matemáticas en la ciencia y tecnología
Bank capital is one of a number of factors often considered where the safety and viability of banks are concerned. Indeed as pointed out by Rosa Lastra330, it is represented by the letter ‘C’ in the acronym ‘CAMELS’331 which was coined in the USA and provides a form of guideline which a significant number of bank managers and regulators take into account when determining the soundness of a bank332.
In a Report by the House of Lords Select Committee on Economic Affairs333, ‘Bank Capital’ was defined as referring:
‘to the part of the bank’s financing that comes from shareholder funds, subordinated debt, certain types of reserves and hybrid debt/equity instruments’334.
328 A K Shah, ‘Dynamics of International Banking Regulation’, (1996) Journal of Financial Regulation & Compliance Volume 4(4), 372.
329
ibid, 373.
330 Rosa Lastra, ‘Risk-based capital requirements and their impact upon the banking industry: Basel II and CAD III’ (2004) Journal of Financial Regulation and Compliance Vol 12(3), 225. 331
See CAMELS n21. 332
Lastra (n330) 225. 333
House of Lords Select Committee on Economic Affairs 2nd Report of Session 2008-2009, ‘Banking Supervision and Regulation’ Volume 1: June 2, 2009, United Kingdom.
Due to the importance335 of banks it is absolutely vital that banks have enough capital (and liquidity), not only for the purpose of undertaking banking business with the view to make profits, but for the fundamental reason that the ability of bank capital to absorb losses, (both expected and arguably unexpected losses), is an important factor in ensuring depositors’ continued confidence in any given bank.
Notwithstanding this, the lack of adequate bank capital could potentially result in the revocation of a bank’s license to operate as a business entity, and where such state of affairs result in bank insolvency, the consequences in most cases can be far-reaching, thus negatively impacting depositors, shareholders (both individual and institutional) and the economy336 at large. It is absolutely important to distinguish economic capital337 from regulatory capital338, which according to Agiwal are both arguably conceptually similar339. Lastra, on the contrary suggests that these two types of capital do not coincide340. Regardless of the mutual exclusiveness i.e. the distinctions or similarities between these two forms of capital, one thing is absolutely certain i.e. the original purpose for which the concept of economic capital was developed by banks has undergone a gradual change over the years.
The shift in focus has been from a role or function as a:
334
ibid 21. Following the introduction of Basel 3, hybrid instruments are being gradually phased out over a 10 year period beginning 1 January 2013 and as a result, this definition would benefit from a revision to exclude hybrid debt/equity instruments.
335
Highlighted in chapter 3 on pages 38-39 of this thesis. 336
Such negative impact may sometimes be felt outside the jurisdiction in which the affected banks are located particularly where shareholders and depositors alike are not based in the same jurisdiction as the affected bank.
337
Economic capital is defined as ‘…….the methods or practices that allow banks to consistently assess risk and attribute capital to cover the economic effects of risk-taking activities’, See BIS Range of practices and issues in economic capital frameworks, p1, March 2009.
338
Regulatory capital on the contrary, refers to that aspect of capital required to address credit risk, as first introduced by the BCBS when the Basel Accord (Basel 1) was first introduced in 1988 and for which Banking regulators globally seek to ensure that banks within their respective jurisdictions strictly adhere to minimum capital charge of 8% of risk-weighted capital.
339 Swati Agiwal, ‘Regulatory and Economic Capital – Measurement and Management’ [2011], 3.
340
‘tool for capital allocation and performance assessment’341…….. to
applications that require accuracy in estimation of the level of capital (or risk), such as the quantification of the absolute level of internal
capital needed by a bank’342.
Greuning and Bratanovic343 suggest that bank capital ensures the continuing level of confidence that depositors have in banks is maintained due to its ability to absorb losses344. While this observation may be true to some extent, it is submitted that the level of confidence depositors may have in the capital levels of any given bank goes only as far as the disclosure of capital by a bank permits, eg say in any given Offering Circular that a bank might issue in the hope of attracting potential investors.
It is further submitted that due to the externality factor of information asymmetry in banks and the fact that the capital (economic or regulatory) of a bank may fluctuate, it is inconceivable that depositors may be aware of such changes in capital positions for it to have any meaningful impact on the level of confidence they might have in a bank. Notwithstanding this view, it is also submitted that the confidence of depositors might be swayed either positively or negatively where pre-tax profits are announced year on year (a sign of a healthy bank) or where an announcement is made that a particular bank has been recapitalised (a sign of a struggling bank) respectively.
Greuning, also suggests that bank capital is the ultimate deciding factor in any bank’s capacity to lend345. Again, it is submitted that this suggestion may not be entirely true, as the ability or capacity of a bank to lend is hinged on the level of leverage that the bank has already undertaken. During the recent global financial crisis, it was discovered that although some banks, particularly in Europe and perhaps elsewhere346 boasted of high capital assets in their
341 BIS, ‘Range of practices and issues in Economic Capital Framework’ [2009], 1. 342
ibid. 343
Hennie van Greuning and Sonja Bratanovic, Analysing and Managing Banking Risk: A Framework for Assessing Corporate Governance and Financial Risk Chapter 6, p105 (World Bank Publications 2003). 344 ibid 102. 345 ibid. 346
In the UK, Northern Rock and Lloyds-TSB were classic examples. See A Milne and G Wood, ‘Shattered on the Rock? British Financial Stability from 1866 to 2007’, (2009), Volume 10, 89-91.
annual reports and banking/trading books, the true position was absolutely shocking as most banks were highly leveraged347 and had no room for manoeuvre. Thus it is submitted that too much leveraging had technically eroded their capital base albeit not evident on the balance sheet.
This, amongst other factors discussed earlier in Chapter 1 contributed to the escalation in capital and liquidity shortage at the onset of the crisis. Another suggestion by Greuning that a bank experiencing capital shortage or high cost of capital ultimately loses out to its competitors in the banking industry348 requires a degree of qualification.
It is submitted that while there is no doubt that a bank experiencing capital shortage is likely to experience some depositor desertion (perhaps not on a very large scale as some depositors are inherently and without reason fiercely loyal), the level of desertion by depositors could potentially increase where banks experiencing a high cost of capital; unilaterally pass on such high costs to consumers (i.e. borrowers, depositors, shareholders etc) without explicit or tacit support from the market industry.
In other words, if the high cost of capital is passed on by all banks within a particular jurisdiction to consumers, then the loss to other banks by way of competition will be minimised but only to the extent that the cost that is passed on to the consumer is not excessively high349.
Finally, another attribute of capital suggested by Greuning which has arguably stood the test of time up until the global financial crisis is the idea that the purpose of capital is to provide financial stability in any given economy through the absorption of losses thus providing a level of protection to stakeholders, particularly depositors following bank insolvency.
347 Some banks were leveraged to about 50 times capital. See B Mahapatra, ‘Implications of Basel 3 for Capital, Liquidity and Profitability of Banks’ [2012] RBI Monthly Bulletin, 775. 348
Greuning and Bratanovic, (n343) 102.
349 In the UK, an announcement in July 2013 that the idea of ‘free banking’ could soon become a thing of the past did not go down well with the general public. Although some aspects of retail banking in the UK are free, the UK banking industry is considering charging between £150 - £200 per annum for certain transactions that are currently free.